Heartland Value Plus Fund 1Q18 Portfolio Manager Commentary

Executive Summary

  • Security selection in a number of areas including Consumer Discretionary and Information Technology (IT) boosted results but Health Care holdings caused the Fund to modestly lag its benchmark, the Russell 2000® Value Index, returning -2.89% versus -2.64%.
  • Investors put a premium on revenue growth over valuations.
  • We believe the strength of the business cycle will prevail and the markets will seek attractively valued businesses.
  • Companies that lack pricing power or which rely on commodities in production could face margin pressure in the quarters ahead.

First Quarter Market Discussion

Investors spent the quarter trying to make sense of conflicting realities at play in the market. On one hand, employment numbers, corporate earnings, and manufacturing data reflected a robust economic backdrop. Yet valuations remain elevated, the Federal Reserve continued to hike rates, and geopolitical tensions simmered beneath the surface.
 
In response to the contradictory realities, investors went back to what has worked previously and put a premium on revenue growth over valuations. The dynamic continues a well-worn trend, as shown, of growth outpacing value. While the pattern has been frustrating to value-focused investors, we believe the strength of the business cycle will prevail and the markets will seek attractively valued businesses that are well positioned to benefit from an improving economy.
 
Russell 2000® Value Less Russell 2000® Growth Index 
10-Year Annualized Rolling Returns
Heartland Advisors R2V Less Growth Chart
Source: FactSet Research Systems Inc., Russell®, and Heartland Advisors, Inc., 1/31/1979 to 3/31/2018, annualized return over rolling 10-year periods. Additional information for indices shown at end of material. All indices are unmanaged. It is not possible to invest directly in an index.
Past performance does not guarantee future results.
 

Attribution Analysis

Security selection in a number of areas including Consumer Discretionary and Information Technology boosted results but Health Care holdings caused the Strategy to lag its benchmark, the Russell 2000® Value Index. Allocation effects were mildly negative, with an underweight to Financials detracting. 
 
Heartland Advisors Value Investing Information Technology Sector IconHelp from the bench. The Fund’s IT holdings were up on an absolute and relative basis and the group contained a solid contributor. Shares of Benchmark Electronics Inc. (BHE) were up after management announced the company was repatriating cash held overseas and adopting a new shareholder friendly capital allocation policy, highlighted by a newly issued dividend and stock repurchase program. The developments were in addition to reporting better-than-expected earnings and revenues along with strong guidance for the upcoming quarter. The company provides contract manufacturing and engineering and design services to OEMs in the medical, defense, aerospace, industrial, and IT industries. Benchmark is committed to profitable growth via targeted high-margin end markets and cost controls.  
 
Heartland Advisors Value Investing Industrials Sector IconInflection in sight? The portfolio’s Industrials names held up better than those in the benchmark, and we continue to find compelling opportunities in the space. For example, Powell Industries, Inc. (POWL), a manufacturer of complex power management systems continues to show promise as sentiment in many of its end markets improves. 
 
Shares of the Houston-based company were off after it reported a decline in year-over-year revenue during the first quarter. We believe a look at order activity provides a clearer picture of where things may be headed for the company. In each of the last three quarters, orders booked have exceeded reported revenue, suggesting the company is on the cusp of future revenue growth.
 
Despite the improving outlook in Powell’s end markets, shares remain undervalued in our view. At 1x tangible book value, shares are trading well below its 20-year average of 1.7x. 
 
Heartland Advisors Value Investing Energy Sector IconEnergized. Despite a soft environment for Energy names, we believe there are some overlooked gems in the group that are well positioned to succeed given current oil prices. Newpark Resources Inc. (NR) is one such example. The energy services company operates in two segments: Fluid systems, and Mats and Integrated Systems. The company’s fluid products enhance drilling performance and provide environmental benefits. Newpark’s composite mats provide a platform to work on during drilling and construction and are a more durable alternative to the popular use of wood panels. 
 
Strength from the Mats segment points to inroads the company has made in broadening its client base beyond the Energy sector. The fluids segment has been gaining market share and is now the second-largest player in the industry. We believe its unique products will help Newpark achieve top line growth as oil continues to trade above $60. 
 
Based on current multiples of just 1.3x stated book value (SBV), we believe Newpark has significant upside.
 

Portfolio Activity  

Economic data continues to reflect a buoyant economy. Corporate earnings are up, unemployment is at lows not seen in more than a decade, and manufacturing activity continues to rise. The vitality of the business climate represents a change from the past several years of a slow grind higher. We acknowledge the pace of growth will ebb and flow, and so we are focused on owning businesses that: 
 
  1. Have strong or improving balance sheets
  2. Are well positioned to expand operating margins through self-help initiatives and idiosyncratic catalysts, and
  3. Are undervalued. 
We continue to believe businesses with opportunities to reduce costs and improve margins through internally focused efforts should be well-positioned to capitalize on operating leverage in an expanding economy or modestly grow earnings should sales plateau.
 

Outlook and Positioning

Heartland Advisors Value Investing Quote ImageThe recent wobble in equity prices has led some investors to question whether valuations have gotten too rich and the bull market is nearing its end. While we don’t call market tops or bottoms, we believe in many cases concerns about valuations are warranted. 
 
As bottom-up investors, we are focused on companies with low debt levels, trading at attractive valuations and with strong business prospects as opposed to the price/earnings of a broad index. As such, we have been finding compelling opportunities among those that will benefit from rising raw material prices. 
 
With economic activity accelerating, we believe raw materials and businesses that produce commodities will move higher. Conversely, companies that lack pricing power or which rely on commodities in production of goods could face margin pressure in the quarters ahead.
 
Thank you for the opportunity to manage your capital.
 
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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Bradford A. Evans

Bradford A. Evans

Evans, CFA, is Senior Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 22 years of industry experience, 19 at Heartland.

Heartland Advisors Value Investing Research Analyst Andrew Fleming

Andrew J. Fleming

Fleming, CFA, is Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 9 years of industry experience, 6 at Heartland.

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In the prospectus (pdf) dated 5/1/2018, the Gross Fund Operating Expenses for the investor and institutional class of the Value Plus Fund are 1.19% and 0.97%, respectively. The Advisor has voluntarily agreed to waive fees and/or reimburse expenses with respect to the institutional class, to the extent necessary to maintain the institutional class’ “Net Annual Operating Expenses” at a ratio not to exceed 0.99% of average daily net assets. This voluntary waiver/reimbursement may be discontinued at any time. Without such waivers and/or reimbursements, total returns may have been lower.

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance information for institutional class shares of Funds that existed prior to their initial public offering is based on the performance of investor class shares. The investment return and principal value will fluctuate so that an investor's shares, when redeemed may be worth more or less than the original cost. All returns reflect reinvested dividends and capital gains distributions, but do not reflect the deduction of taxes that an investor would pay on distributions or redemptions. Subject to certain exceptions, shares of a Fund redeemed or exchanged within 10 days of purchase are subject to a 2% redemption fee. Performance does not reflect this fee, which if deducted would reduce an individual's return.

An investor should consider the Funds’ investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information may be found in the prospectus (pdf). To obtain a print prospectus, call 800-432-7856. Please read the prospectus carefully before investing.

As of 3/31/2018, Benchmark Electronics Inc., Newpark Resources Inc., and Powell Industries, Inc. represented 2.68%, 1.66%, and 2.89% of the Value Plus Fund’s net assets, respectively.

Portfolio holdings are subject to change without notice. Current and future portfolio holdings are subject to risk.

The statements and opinions expressed in the articles or appearances are those of the presenter. Any discussion of investments and investment strategies represents the presenters' views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. The specific securities discussed, which are intended to illustrate the advisor’s investment style, do not represent all of the securities purchased, sold, or recommended by the advisor for client accounts, and the reader should not assume that an investment in these securities was or would be profitable in the future. Certain security valuations and forward estimates are based on Heartland Advisors’ calculations. Any forecasts may not prove to be true.

Economic predictions are based on estimates and are subject to change.

There is no guarantee that a particular investment strategy will be successful.

Sector and Industry classifications are sourced from GICS®.The Global Industry Classification Standard (GICS®) is the exclusive intellectual property of MSCI Inc. (MSCI) and S&P Global Market Intelligence (“S&P”).  Neither MSCI, S&P, their affiliates, nor any of their third party providers (“GICS Parties”) makes any representations or warranties, express or implied, with respect to GICS or the results to be obtained by the use thereof, and expressly disclaim all warranties, including warranties of accuracy, completeness, merchantability and fitness for a particular purpose.  The GICS Parties shall not have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of such damages.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell Microcap®, small-cap by the Russell 2000®, mid-cap by the Russell Midcap®, large-cap by the Russell Top 200®.

Growth and value investing each have unique risks and potential for rewards and may not be suitable for all investors. A growth investing strategy emphasizes capital appreciation and typically carries a higher risk of loss and potential reward than a value investing strategy; a value investing strategy emphasizes investments in companies believed to be undervalued.

Because of ongoing market volatility, performance may be subject to substantial short-term changes.

Additional Information for Indices in Chart (calendar year returns %):

    1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD 2018*
Russell 2000® Growth Index   20.17 -17.41 51.19 7.77 13.37 -2.43 31.04 11.26 12.95 1.23 43.09 -22.43 -9.23 -30.26 48.54 14.31 4.15 13.35 7.05 -38.54 34.47 29.09 -2.91 14.59 43.29 5.62 -1.38 11.32 22.17 2.30
Russell 2000® Value Index   12.43 -21.77 41.70 29.14 23.77 -1.54 25.75 21.37 31.78 -6.45 -1.49 22.83 14.02 -11.43 46.03 22.25 4.71 23.48 -9.78 -28.92 20.58 24.50 -5.50 18.05 34.50 4.22 -7.47 31.74 7.84

-2.64

*As of 3/31/2018
Source: FactSet Research Systems Inc. and Russell®
Past performance does not guarantee future results.

An original equipment manufacturer (OEM) is a company whose goods are used as components in the products of another company, which then sells the finished item to users.

Heartland’s investing glossary provides definitions for several terms used on this page.

The above individuals are registered representatives of ALPS Distributors, Inc.

CFA® is a registered trademark owned by the CFA Institute.

The Heartland Funds are distributed by ALPS Distributors, Inc.

The Value Plus Fund invests in small companies that are generally less liquid and more volatile than large companies. The Fund also invests in a smaller number of stocks (generally 40 to 70) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund’s returns.

Value investments are subject to the risk that their intrinsic value may not be recognized by the broad market.

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